Europe

While Europe Seeks Compromise on Sanctions, Putin Could Cut Off the Gas

As the European Union inches down the path of sanctions against Russia, Moscow looks ready to take a far more drastic step. Gazprom (GAZP:RM), the country’s gas export monopoly, said on Monday that it’s prepared to cut off all supplies to Ukrainian pipelines as early as June 3.

According to Gazprom Chief Executive Officer Alexey Miller, supplies will be halted unless Ukraine meets a June 2 deadline to prepay for shipments during that month. The cutoff would affect not only Ukraine but also EU countries that rely on Russian gas transshipped via Ukraine. Gazprom says it’s ready to act because Ukraine owes it more than $3.5 billion for past shipments.

The announcement highlighted the relative ease with which the Russian government can tighten the economic screws on Europe—in contrast to the EU, which seeks compromises among the interests of member countries. Just this week, France rejected calls from European and U.S. allies to block the planned sale of two warships to Russia. A high-ranking French official said France is unwilling to be the only country taking a meaningful hit on sanctions. The warship deal is worth an estimated $1.7 billion, and France would have to pay cancellation penalties if the sale were blocked.

The EU today said it would place sanctions on two Crimean companies that were expropriated by Russia when President Vladimir Putin annexed the Ukrainian peninsula. Other than those companies, which weren’t immediately identified, the EU has targeted a few dozen individual Russians and Ukrainians with asset freezes and visa bans.

By contrast, a gas cutoff by Russia would wipe out half of Ukraine’s supply and could severely disrupt supplies to several EU countries, including Italy as well as several Eastern European nations, says Graham Freedman, a senior analyst at consulting firm Wood Mackenzie in London. All told, Europe gets about one-third of its gas from Russia. About half of that comes via Ukrainian pipelines.

The effect of a shutoff wouldn’t be felt immediately. Gas demand is at its lowest during the summer, and Ukraine and Europe have stockpiled enough to last at least two months, Freedman says. Ukraine has enough domestic gas production to meet 75 percent of its needs during summer, he says. And Russia could shift some supplies to Europe to pipelines that bypass Ukraine.

As temperatures drop in the fall, though, the situation could quickly become dire. Alternative pipeline routes passing to the north of Ukraine don’t have sufficient capacity to meet all of Europe’s needs, Freedman says: “Italy would really struggle,” since much of its gas is shipped via Ukraine.

That, in turn, is likely to make the Italian government reluctant to hit Russia with painful sanctions. Besides its dependence on Russian gas, Italy has substantial business interests in Russia, including Arctic exploration ventures with state oil group Rosneft (ROSN:RM). Italian Premier Matteo Renzi has joined other European leaders in saying Russia should be punished if it continues to interfere in Ukraine. But when G-7 energy ministers met in Rome last week to discuss possible alternatives to reliance on Russian gas, Renzi declined to talk about sanctions. The subject “isn’t part of today’s discussion,” he said.

The best protection Europe may have against an abrupt gas cutoff is that Russia’s economy is in a slump, and the Kremlin badly needs revenue from its foreign gas sales. It’s eyeing new markets in Asia, but those will take years to develop. Freedman suspects the Russians will seek to negotiate higher prices with Ukraine, rather than halting shipments. “That would be the sensible option,” he says.